The Ownership Society

In an effort to restore confidence to the ailing financial system, President George W. Bush on Tuesday announced plans to directly inject billions of dollars of capital directly into banks and expand the role of the Federal Deposit Insurance Corporation.

The plan--part of the $700 billion bailout package passed by Congress last week--will allot $250 billion for purchase of preferred shares in banks of all sizes and states of economic health. Nine banks have already agreed to take cash injections:
Bank of America
,
Citigroup
,
Wells Fargo
,
JPMorgan Chase
,
Morgan Stanley
,
Goldman Sachs
,
Bank of New York Mellon
, State Street and
Merrill Lynch
(which is being acquired by Bank of America). Treasury officials would not confirm the amounts that each bank will receive.

"These measures are not intended to take over the free market, but to preserve it," Bush said.

Making direct, perpetual preferred stock investments in the biggest U.S. banks is the government's most aggressive move yet to stop the carnage in the credit markets. The move follows the heels of similar action by European countries, including France, Germany and Great Britain, Monday. If the U.S. did not act, there was a risk of capital fleeing the United States for safer havens in Europe. Still, the U.S. move has the potential to divide winners from losers in the world of commercial banking, because the government wouldn't put taxpayer dollars at risk, presumably, by investing directly in an ailing bank that could otherwise be merged with a healthy bank or closed.

It also puts the biggest banks squarely in the hands of federal regulators, and taxpayers, for several years, a stunning reversal of thinking for an administration that had championed free-market capitalism before this crisis erupted.

Under the Capital Purchase Program, the Treasury will purchase senior preferred shares in banks. The shares will pay a 5% dividend, and will rank senior in a firm's capital structure to common stock. After five years, the dividend will reset to 9%, if the bank has not repurchased them.

The government's stakes in banks will be non-voting. The Treasury will also receive warrants to purchase common stock, comprising up to 15% of the senior preferred investment. In order to participate, firms will have to agree to executive compensation restrictions, for as long as Treasury holds stakes in the firm.

The senior preferred shares will be callable at par after three years, under the Treasury program. Treasury will also have discretion to transfer its shares to a third party at any time. The program will be available on the same terms to other banks across the country that elect to participate before 5 p.m. Nov. 14.

Under the program announced this morning, the FDIC will insure new bank debt in the Temporary Liquidity Guarantee Program. New senior unsecured debt issued on or before June 30, 2009 is fully protected if a bank fails or its holding company files for bankruptcy. This coverage is limited for three years.

The FDIC will also expand deposit insurance for non-interest-bearing transaction accounts used by many small businesses. Many businesses that had accounts larger than the Federal Deposit Insurance limit, currently $250,000, were pulling accounts from smaller banks and moving them to larger, safer banks. Under the new program, the FDIC will provide full insurance coverage for non-interest- bearing accounts until the end of next year. Banks will pay a new premium to cover the expense of the program.

"Today's actions are not what we ever wanted to do--but today's actions are what we must do to restore confidence to our financial system," said Treasury Secretary Henry Paulson.

Federal Reserve Chairman Ben Bernanke added: "We will not stand down until we have achieved our goals of repairing and reforming our financial system, and thereby restoring prosperity to our economy."

The actions taken by the Treasury Tuesday fall under the rubric of the Troubled Assets Relief Program that is the centerpiece of the bailout bill Congress passed earlier this month. Treasury still has in place plans to purchase toxic assets to clean up banks' balance sheets, but the administration's primary goal now seems to be direct injection of capital into banks. Also Tuesday, President Bush took the next step in the bailout measure, by officially asking Congress for $350 billion to help banks. He can request an additional $350 billion as needed, subject to Congress' disapproval.

A Treasury official said Tuesday that $250 billion will be spent to buy preferred shares in banks by the end of the year. The amount that will go to the nine banks mentioned above will be doled out in a matter of days. The official said the Treasury arrived at the $250 billion figure in consultation with finance industry leaders. However, the figure is not based on a specific data point. Since the program is voluntary, Treasury will be able to learn of its success largely by the number and type of banks that elect to participate.